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Comprehensive analysis of Taxation on Provident Fund (PF) and NPS





 

Taxation of Employee Provident Fund


Until recently, the Provident fund (PF) contributed, and interest thereon was out of tax ambit. However, recent changes to the income tax laws in India have proposed to tax the PF contributions and interest income over certain limits. This blog summarizes the taxation aspects relating to PF, including:


1. Taxation of PF at the time investment by employee and employer.

2. Taxation on interest earned on PF money. On both balances – employee’s and employer’s contribution.

3. Taxation of PF at the time of withdrawal.


Let’s analyze in detail.


Part A: Table 1: Summary of PF taxation:

Particulars of event

Employer’s Contribution

Employee’s Contribution

Contribution to PF

As per Union Budget 2020, employer’s contribution to Provident Fund, National Pension Scheme (NPS) and Superannuation Fund more than Rs.7.5 lakh will be taxable as perquisites in the hands of the employee.

Exepmt

Interest on PF

Refer notes below and Part B for illustration

As per Union Budget 2021, the interest earned on the Employees’ Provident Fund (EPF) account as relatable to contributions more than Rs.2.50 lakh will be taxable. For example if you contributed Rs. 3 lacs to EPF account, interest earned on 50,000 will be taxable.

Withdrawal of PF

(Before 5 years of continuous service)

Employer’s contribution and interest on it is fully taxable. Employer’s contribution is taxed under the head salary in your tax return. Interest is taxed under income from other sources.

When TDS is deducted on it, you are likely to see an entry under salary TDS in your Form 26AS for it.

1. Deduction u/s 80C availed at the time of investment- Taxable as Income from Salary.

If Deduction u/s 80C not availed at the time of investment- Not Taxable

2. The Interest portion will be taxed as income from other sources.

Withdrawal of PF

(After 5 years of continuous service)

Exempt

Exempt

Notes:

  1. Interest taxability shall be applicable only for the contribution made on or after April 1, 2021. If you have accumulated balance before 1st April 2021, interest thereof will not be taxable.

  2. Interest earned by the employee till 31st March 2021 are not taxable.

  3. The newly inserted Rule 9D has specified that separate accounts within the PF Accounts shall be maintained clearing segregating the taxable and non-taxable contributions to PF along with interest thereon.

a. Non-taxable Contribution Account

b. Taxable Contribution Account


Part B: Illustrations:


I. Calculation of taxable portion of Interest on PF – relating to fund contributed by employee:

Month

Monthly Employee Contribution

Balance at the end of each month (Cumulative)

Interest @ 8.5% (illustrative rate)

Non-Taxable

Taxable

April 21

30,000

30,000

213

213

0

May 21

30,000

60,000

425

425

0

June 21

30,000

90,000

638

638

0

July 21

30,000

1,20,000

850

850

0

Aug 21

30,000

1,50,000

1,063

1,063

0

Sep 21

30,000

1,80,000

1,275

1,275

0

Oct 21

30,000

2,10,000

1,488

1,488

0

Nov 21

30,000

2,40,000

1,700

1,700

0

30,000

2,50,000

1,771

1,771

0

Dec -21 (This months contribution is split in two parts)

2,70,000

142

0

142

Jan 22

30,000

3,00,000

2,125

1,771

354

Feb 22

30,000

3,30,000

2,338

1,771

567

Mar 22

30,000

3,60,000

2,550

1,771

779

Total

3,60,000

16,578

14,736

1,842

II. Summary of above:


Sr.No.

Particulars

Total

Non-taxable Account

Taxable Account

1

Opening Balance as of 01 Apr 2021

50,00,000

50,00,000

-

2

Contribution made up to threshold limit / excess of limit in 2021-22

3,60,000

2,50,000

1,10,000

(Exceeding 2.50 lacs is taxable)

3

Interest accrued on the amount within threshold / above threshold limit

16,578

14,736

1,842

Closing Balance as on 31 Mar 2022

-

52,64,736

1,11,842


III. Calculation of taxable portion of Interest on PF – relating to fund contributed by employer:


As the Employer’s contribution above Rs. 7.5 Lakhs will be taxable, the interest on such excess contribution is taxable us 17(2) (viia) as per Rule 3B.


Rule 3B provides the below formula to calculate the taxable perquisite u/s 17(2)(viia):


TP = (PC/2)*R + (PC1+TP1)*R

Where,

TP=Taxable perquisite under u/s 17(2)(viia) of the Act for the current previous year;


TP1=Aggregate of taxable perquisite u/s 17(2)(viia) of the Act for the previous year or years commencing on or after 1st day April, 2020 other than the current previous year


PC=Amount or aggregate of amounts of principal contribution made by the employer in excess of Rs. 7.5 lakh to the specified fund or scheme during the previous year


PC1=Amount or aggregate of amounts of principal contribution made by the employer in excess of Rs. 7.5 lakh to the specified fund or scheme for the previous year or years commencing on or after 1st day April, 2020 other than the current previous year


R=I/Favg


I=Amount or aggregate of amounts of income accrued during the current previous year in the specified fund or scheme account;


Favg=(Amount or aggregate of amounts of balance to the credit of the specified fund or scheme on the first day of the current previous Year + Amount or aggregate of amounts of balance to the credit of the specified fund or scheme on the last day of the current previous year)/2.

Example:

Particulars

Year 1

Year 2

Year 3

Year 4

Year 5

Opening balance of specified funds (A)

50,00,000

64,40,000

82,03,200

91,19,200

4,88,700

Employer contribution during the year (B)

10,00,000

12,00,000

2,50,000

-

-

Withdrawal during the year (C)

-

-

-

(90,00,000)

-

Annual accretion during the year (interest etc.) (D)

4,40,000

5,63,200

6,66,000

3,69,500

39,100

Closing balance of specified funds (E)= (A+B-C+D)

64,40,000

82,03,200

91,19,200

4,88,700

5,27,800

IV. Taxable Perquisite TP = (PC/2)*R + (PC1+TP1)*R

Particulars

Year 1

Year 2

Year 3

Year 4

Year 5

PC=(B)-7,50,000 or 0 whichever is high

2,50,000

4,50,000

-

-

-

I= (D)

4,40,000

5,63,200

6,66,000

3,69,500

39,100

Favg= (A+E)/2

57,20,000

73,21,600

86,61,200

48,03,950

5,08,250

R= I/Favg

7.69%

7.69%

7.69%

7.69%

7.69%

PC1 (Aggregate PCs of all earlier years)

-

2,50,000

7,00,000

7,00,000

7,00,000

TP1 (Aggregate TPs of all earlier years)

-

9,615

46,893

1,04,326

1,66,191

Excess of TP1+PC1 over Opening balance(A)

-

-

-

-

3,77,491

TP = (PC/2)*R + (PC1+ TP1)*R

9,615

37,278

57,432

61,865

37,596

Perquisite u/s 17(2)(vii) = PC

2,50,000

4,50,000

-

-

-

Total taxable perquisite

2,59,615

4,87,278

57,432

61,865

37,596

Note:


To calculate annual accretion at (D), we have used interest rate of 8% on opening balance and 4% on contribution/withdrawal during the year on the assumption that contribution/withdrawals have been made uniformly during the year.



V. Notes on Withdrawal of PF:


  1. If you withdraw from EPF before completing 5 years of continuous service, TDS will be deducted. In calculating 5 years of service, your tenure with the previous employer is also included.

  2. When you change jobs, try not to withdraw the EPF amount, instead you can continue the same account with new company.

  3. If withdrawal amount is less than Rs 50,000, no TDS is deducted.

  4. Withdrawal of EPF (both Employer’s and Employee’s contribution and Interest on it) after 5 years of continuous service: No TDS. Further, the individual need not offer the same in the return of income as such withdrawal is exempt from tax


The EPFO in line with the newly inserted Rule 9D shall provide separate account statements within the PF Accounts. The EPFO will maintain the taxable and non-taxable contributions to PF along with interest thereon. This might make the PF taxation more streamlined.



 

Taxation of NPS


The National Pension Scheme is a voluntary retirement scheme introduced by the Central Government. Similar to Employee Provident Fund, the contribution made by employer to the NPS account will become taxable if the total amount of PF, Superannuation and NPS exceeds Rs. 7,50,000 in a year.


Employee's own contribution to NPS will not be taxable in any case. This is simply because employee will be making contribution to NPS from tax paid money.


Further withdrawal from NPS is permitted in very specific manner. Please read below:


One can invest in such NPS account regularly and receive 60% of it as a lump sum amount on attainment of 60 years of age and the remaining as annuity pension. If one withdraws in excess of 60% of NPS balance, such excess withdrawal will become taxable in the hands of taxpayer as regular income.


However, the scheme also allows partial withdrawal from the NPS account before attaining the age of 60.


Withdrawal from NPS:


There are two types of NPS accounts- Tier I and Tier II. If you wish to subscribe to NPS it is mandatory for you to open a Tier-I account. Tier-II is an add-on voluntary savings account to a Tier-I account holder with flexible rules. There are no such restrictions on withdrawals from Tier-II accounts. Also, there is no tax benefit on the contributions made to Tier-II account except in case of a central government employee. Partial withdrawal from a Tier-I account is possible under certain circumstances.

Withdrawal terms and conditions

  • Partial withdrawal from a Tier-I account is allowed only under following circumstances:


  • Higher education of children;

  • Marriage of children;

  • Purchase or construction of residential house or flat in own name or in joint name with the spouse;

  • Treatment of specified illnesses;

  • Setting up a new venture or start-up; or

  • Meeting expenses for skill development, reskilling or self-development activities.

Further:

  • A maximum of 3 withdrawals are permitted during the entire tenure, i.e. date of joining till 60 years of age;

  • You must have been in the National Pension System for at least three years from the date of joining; and

  • Maximum withdrawal of 25% of the contributions made by you is permitted. If your employer has also made contributions to your NPS account, note that only a maximum of 25% of your share of contributions can be withdrawn.

  • There must be gap of at least 5 years between 2 withdrawals.

Tax Treatment on partial withdrawal from NPS

  • 25% of the permissible withdrawal from the NPS account is tax-free if above conditions are fulfilled.

  • Withdrawal in contradiction to above conditions will lead to such withdrawal getting added to taxable income.

What are specified illness?

The Pension Fund Regulatory and Development Authority (PFRDA) has specified the following as specified illnesses:

  • Cancer

  • Kidney failure

  • Primary Pulmonary arterial Hypertension

  • Multiple Sclerosis

  • Major Organ Transplant

  • Coma

  • Myocardial infarction

  • Stroke

  • Heart Valve surgery

  • Aorta Graft Surgery

  • Paralysis

  • Serious Life-threatening accidents

  • Coronary Artery Bypass Graft

  • Total blindness

  • Covid-19

  • Any other illness specified by PFRDA, which critical in nature and life threatening.


Thus one should plan the investments and withdrawal from PF and NPS after thoroughly considering the rate of return, lock in period, withdrawal terms and internal rate of return. There is no such rule as to which is better when comparing PF and NPS. Both carries separate sets of advantages and disadvantages which will affect an individual's decision making.


-Compiled by- Amruta Sohani

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